That’s not fair! Or is it? Fair value explained.
As if all of us haven’t been busy enough implementing the two new pension standards (GASB Statements 67 and 68), the Governmental Accounting Standards Board (the GASB) recently issued GASB Statement 72, Fair Value Measurement and Application. Let’s talk about what that means for you.
This new statement effectively does three things:
- It addresses to some extent which assets and liabilities should be measured at fair value and identifies certain assets that should not be measured using fair value.
- It provides for a new definition of fair value, akin to that provided by the Financial Accounting Standards Board (FASB), and goes into much more detail than prior GASB standards about how fair value should be measured.
- The new standard provides required disclosures about fair value in the notes to the financial statements.
GASB defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. It is based on an exit price notion similar to the fair value concept that FASB uses.
Generally, all investments will be measured at fair value. However, this Statement does carry forward from existing GASB standards a number of exceptions for certain investments that should be valued differently, including money market investments and participating interest-earning investment contracts with a remaining maturity of one year or less, which can be valued at amortized cost.
Additionally, certain assets which, in the past were valued at fair value, will now be valued at acquisition value. Acquisition value, unlike fair value, is an entry price notion; GASB defines it as the price that would be paid to acquire an asset with equivalent service potential in an orderly market transaction at the acquisition date. The assets that must use acquisition value on a go-forward basis include donated capital assets and donated works of art or historical treasures.
GASB delineates three acceptable valuation techniques to determine fair value: market approach, cost approach and income approach. These valuation methodologies are not new, but they have not been specified previously in GASB literature. Fortunately, GASB also allows governments to establish fair value by using the Net Asset Value (NAV) per share or equivalent. Here again, this is not dissimilar to methodologies already in place today by governments to value certain harder to value assets, but GASB has now brought this guidance officially into their standards. For most governments, this Statement will have the most significant impact on the footnote disclosures. Beginning with June 30, 2016 fiscal year ends, GASB now requires that assets or liabilities valued at fair value be categorized into 3 levels.
Those levels are:
- Level 1 – based on quoted market prices for identical assets/liabilities, which means you can go to a public exchange and value the asset or liability. Examples of level 1 investments would include publicly traded mutual funds and common stock.
- Level 2 – based on other observable inputs (not quoted in the market). An example of a level 2 investments would be common collective trust funds, mortgage-backed securities, and most interest rate swaps.
- Level 3 – based on unobservable inputs, meaning assumptions are involved in the valuation and often times the valuation is made based upon the best information available. Examples of level 3 investments would include limited partnerships (private equity funds), commercial real estate, and real estate investments that are not publicly traded.
Investments in entities that calculate the NAV per share (or its equivalent), such as hedge funds, often cannot be traded and, therefore, market-based information regarding their value may not exist. Many governments already use the NAV per share (or its equivalent) as a measure of fair value. GASB acknowledged that this appropriate, however, that categorizing such investments according to the fair value hierarchy would prove to be difficult and produce inconsistent disclosures. Therefore, investments valued at NAV excluded from the categorization levels above.
- Fair value measurement at the measurement date, including a description of the significant investment strategies of the investee
- Liquidation period, redemption period and unfunded commitments, if any
- Redemption restrictions, if any
- Disclosure of the nature and risk of investments valued at NAV, along with information regarding whether those investments will be sold for a value different than fair market value.